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Match Group(NASDAQ:MTCH) is the company behind Tinder and several other popular dating websites and apps. The company has a leading market position its main business, its financial performance looks quite promising, and the stock is priced at fairly reasonable levels when compared to other social network companies such as Facebook(NASDAQ:FB) and Twitter (NYSE:TWTR).

Match Group is quite a risky proposition for investors at this stage. However, there are strong reasons to believe that the stock could deliver substantial gains if things work out as expected over the coming years.

The business

Match Group is the world's leading provider of online dating websites and applications. The company operates a portfolio of over 45 brands in more than 190 countries, including names such as Tinder, Match.com, and OkCupid, among several others. In addition to its dating business, the company operates The Princeton Review, which provides a variety of test preparation, academic tutoring, and college counseling services.

The company's average paid member count (APC) grew by a vigorous 36% year-over-year last quarter, reaching 5.1 million. Tinder is the crown jewel of the business, and it has been enjoying growing popularity over the last several years. The platform recently launched its first-ever paid feature, and it ended the first quarter with more than 1 million paying customers. According to recent comments from management, the company is expecting to double the number of paying Tinder subscribers by the end of the year.

Management calculates that the business, has a massive addressable market of nearly 511 million single Internet users in the U.S., Europe, and other select countries. This indicates that the company has barely taken its first steps in terms of capitalizing on its long-term growth opportunities.

Competition is an important risk to watch, since Match Group operates in an social media industry dominated by much larger players like Facebook and Twitter. Facebook had 1.65 billion monthly users as of the first quarter, and Twitter reported 310 million monthly users during the same period. On the other hand, Match Group owns multiple valuable brands in the online dating space, and those users who are serious about online dating will probably feel more inclined to use platforms specifically designed for those activities.

Facebook and Twitter make most of their sales from online advertising, while Match Group is barely getting started in this area. The company hired Peter Foster to lead its global advertising team in March of this year. The executive (who previously worked as chief revenue officer for Wrap Media) believes Match Group could gain substantial ground in advertising. In his own words:

There are very few global publishers with this level of scale, mobile user engagement, and sophisticated targeting potential. Tinder is a huge potential advertising asset, and Match, Meetic, OkCupid, PlentyOfFish and the rest of the network provides substantial global heft and breadth. I believe that this is the very early stage of ramping and that we have huge upside here.

Competition is a two-way street in social media. Facebook and Twitter could hurt Match Group if they expanded into online dating services, but Match Group also has a lot of room for growth in online advertising.

The numbers

Match Group is testing different subscription models and pricing options at its various platforms, which has the potential to make financial performance quite volatile over time. On the other hand, financial reports for the first quarter of 2016 show that the main variables are clearly moving in the right direction.

Total revenue during the quarter amounted to $285 million, a healthy increase of 21%. Dating revenue increased 24% to $260 million on the back of vigorous growth from Tinder and the recent acquisition of PlentyOfFish. On the other hand, revenue from The Princeton Review was flat at $25 million during the quarter.

The company produced $75 million in operating cash flow and $68.5 million in free cash flow during the quarter, while adjusted EBITDA margin expanded from 14% of sales in the first quarter of 2015 to 23% of revenue.

Match Group carries a forward P/E ratio of 22 times, a substantial discount versus a forward price-to-earnings ratio of 26 for Facebook and on par with Twitter's P/E of 22. If management proves to investors that it can continue capitalizing on its opportunities and driving strong growth over the coming years, then Match Group could deliver big returns from currently attractive valuation levels.

On risk and reward

Match Group is a fairly young company operating in an emerging industry, and it's still experimenting with pricing models. Both of those points mean that financial performance can be hard to predict, and investors will want to keep a close eye on the competitive dynamics in the industry. If you are looking for a solid and well-established business generating predictable cash flows, then Match Group is clearly not your one and only.

On the other hand, the company is a market leader in a promising niche, its key financial variables look quite strong, and valuation is fairly attractive considering the company's potential for growth. If you are willing to assume above-average risk to invest in a business with huge upside potential over the years ahead, then you may want to consider a long-term relationship with Match Group.

Andrés Cardenal has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Facebook and Twitter. The Motley Fool recommends Match Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Author

Andres Cardenal, CFA is a tenacious researcher of the best investment opportunities around the world. Andres is an economist and CFA Charterholder living in Buenos Aires, Argentina. Naturally flavored.
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